Equipment Leasing vs. Financing | Bankrate

Access to the right equipment may be essential to your business’s growth. However, buying it outright can be costly, especially for newer businesses or those with limited capital. Whether you need office technology, semi-trucks, tractors or heavy machinery, the upfront expense can be a major barrier.

While general business loans can help, exploring equipment leasing vs financing can help you secure essential tools for your business without a large upfront investment. Getting an equipment loan allows you to purchase equipment over time and eventually own it, while equipment leasing offers lower monthly payments and flexibility if you plan to upgrade frequently.

Understanding the differences between equipment leasing and financing can help you choose the best option for your budget, cash flow and long-term goals.

Equipment leasing vs. financing

Both leasing and financing give your business access to the equipment it needs to function. An equipment lease works as a rental agreement and generally has a lower month-to-month cost than a business loan. However, your business may lose access to the equipment and any residual value that equipment may still have once the lease ends.

Equipment financing allows you to purchase equipment and spread the cost of the purchase over a period of time. Since you own the equipment, you can list and use the equipment as an asset to your business.  

Here are some of the key differences between equipment leasing and financing:

Both are valid options for business owners. Just keep in mind how you plan to use the equipment and what it will cost to keep and maintain it each month.

What is equipment leasing?

Equipment leasing is what gives you access to much-needed equipment without the higher monthly cost associated with a loan. In many cases, your business can also avoid a down payment, saving you thousands.

It is a common choice for businesses that don’t have the capital to purchase a piece of equipment outright or afford a down payment. Depending on the type of lease, you will either rent and return the equipment or purchase it with a balloon payment at the end of the lease period.

How equipment leasing works

Equipment leasing works by allowing you to rent equipment from a leasing company. You make a monthly payment to use the equipment over a set period of time, such as two to five years. The lease may or may not include maintenance and repairs as part of the agreement.

Once the lease ends, you may have the option to buy the equipment for a price determined by the leasing company. Otherwise, you do not own this equipment and must give it back to the leasing company.

Types of equipment leases

There are two primary lease options available to businesses: capital and operating.

• Capital lease: A capital lease allows you to purchase the equipment at the end of the lease period. You pay insurance and taxes on the equipment, maintain it and can count it as a liability. At the end of the lease, you can buy the equipment. This may result in a balloon payment where you owe the remaining amount that wasn’t paid through the lease at once.
• Operating lease: An operating lease is a short-term rental agreement that allows you to rent the equipment for a specific period and give it back once the lease ends. You can cancel as needed and are generally not responsible for maintenance. However, you may not be able to buy the equipment at the end of the lease period and can’t count it as a liability for tax purposes.
• Fair market value (FMV) lease. This type of lease allows you to buy the equipment at the end of the lease at the equipment’s fair market value.
• $1 buyout lease. This type of lease allows you to buy the equipment at the end of the lease for a minimal price of $1. Unlike other leases, you also own the equipment during the lease period and can list and treat the equipment as a business asset.
• Terminal rental adjustment clause (TRAC) lease. This type of lease allows you to lease commercial vehicles, possibly at a lower cost than other leases or loans. You can negotiate with the leasing company for a lower payment based on the residual value of the vehicle. Then, if you choose, you can buy the vehicle at the end of the lease, paying the remainder of the vehicle’s value that you didn’t pay during the lease term.

The type of lease you agree to will depend on the company you work with, the equipment you need and the duration of the lease itself.

For example, a capital lease may be better if a larger piece of machinery is too expensive to purchase outright, but your business can afford to maintain and insure it. An operating lease is better suited for equipment that quickly becomes outdated.

Cost of equipment leasing

The cost of leasing equipment can vary widely depending on the type of equipment and lease you choose. You may also be responsible for a few common fees.

Pros and cons of equipment leasing

What is equipment financing?

Equipment financing, also known as equipment loans, is the process of borrowing money to purchase a piece of equipment or machinery. They are especially handy for equipment your business will need for years to come. If it is unlikely to become obsolete or unrepairable, a loan allows you to own the equipment outright. Once you do, you can use or sell it. 

Many businesses prefer an equipment loan to a small business loan because the equipment acts as collateral, which may result in better terms and interest rates.

After you receive the funds, manage your equipment loan wisely. Late payments can cause fees to rack up and could potentially impact your credit. Since the monthly payment on an equipment loan is generally higher than on a lease, you may need to carefully control your cash flow to make your payments in full.

How equipment financing works

An equipment loan offers you a lump sum of money once you sign for the loan. You can use that loan to pay for the equipment your business needs. Then, you repay the loan over a specific term, such as two to five years, with interest. Interest on an equipment loan is usually lower than other types of loans because it’s a secured loan. You own the equipment outright after the loan; however, the lender can seize the equipment during the loan if you fail to make payments.

Where to get an equipment loan

You can find equipment loans through various sources, including banks and alternative lenders. Equipment loans may also be available directly through the seller.

If you’re looking for the lowest interest rates, traditional banks and credit unions offer the most competitive rates. You can also talk with a loan officer in person to walk through the loan process. However, these banks tend to have strict eligibility requirements and may not be available to business owners with fair or poor credit or low revenue.

On the other hand, some of the best equipment business loans are through online  lenders because of their speed and minimal requirements. For instance, iBusiness Funding (formerly Funding Circle) has a low revenue requirement for business owners, and many other top online lenders only require a minimum personal credit score of 600.

Cost of equipment financing

Like most business loans, several common fees are associated with the cost of financing equipment.

Pros and cons of equipment financing

Equipment leasing vs. financing: Which should I choose?

Equipment financing may be the best option if you want to own the equipment as an asset. Rather than spending money on an asset you won’t own, you will have some equity in the equipment during and after the loan period. If an unexpected event happens in your business, you can sell the equipment to pay for a large expense.

On the other hand, equipment leasing can help you get equipment you need without having a large down payment or high monthly loan repayment. It’s ideal if the lease payment comes out to a lower amount than a loan repayment. You may also want to ensure that you can buy out the equipment at the end of the lease, giving you ownership. 

Equipment leasing works best if you don’t have the money upfront for a down payment, can’t afford a loan repayment or need up-to-date equipment for your business.

Tax benefits of equipment leasing vs. financing

Either way, you get tax benefits for using equipment whether you lease or finance it. With equipment leasing, you can deduct the total lease payment as a business expense. With equipment financing, you can deduct the amount of interest you pay on the loan. 

With equipment financing, you can also deduct the equipment’s cost on your business taxes over the course of several years. Or you can choose to deduct the full purchase cost during the first year of service, under section 179 of the tax code. You’ll want to consult a tax professional to ensure accuracy when taking these deductions.

Requirements for equipment leasing and financing

Leasing and financing equipment have similar requirements for approval. To get an equipment loan, you can expect to show proof of:

• At least two years in business
• Personal credit score in the good to excellent range
• Annual revenue of $100,000 or more

To lease a piece of equipment, you may need to stay within  a maximum amount — some equipment is too inexpensive to lease. Other qualifications vary, and many lenders will require you to exceed the minimum eligibility requirements to score the lowest rates on the best loan or lease. It’s best to be prepared with the documents needed to get an equipment loan, such as bank statements and tax returns, to expedite the application process.

Debt service coverage and credit history

When getting equipment leasing and financing, expect companies to look closely at your personal and business credit. In cases where you’re a small business or have limited business credit history, companies may lean heavily on the financial picture provided by your personal credit report. 

If you have a strong track record of on-time payments, you’re more likely to get approved for a loan or a lease – and with more favorable interest rates and repayment terms. If you don’t have strong credit, expect to pay more in interest and fees.

For equipment loans, lenders may use a ratio called the debt service coverage ratio to determine whether you can repay the loan. The DSCR tells lenders how much revenue you generate compared to how much debt you have. Lenders typically like to see a DSCR of at least 1.25, meaning that your revenue is 1.25 times that of your debt repayments. 

Bottom line

Both equipment leasing and financing  are useful ways to get your business the equipment it needs. Leasing is one of the top alternatives to equipment loans because it has a generally lower monthly cost and doesn’t require a down payment. But equipment financing allows you to build equity, and you’ll own the equipment at the end of the loan. 

Ultimately, the right choice will depend on your business and the type of equipment you plan to use. Long-lasting machinery may be better funded with a loan, while a lease may be better for tech that sees frequent updates. Consider overall cost and end-of-loan or end-of-lease scenarios when making your decision.

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